Q&A: China's market turmoil a symptom of other problems

HONG KONG – Calm returned Friday to China's stock markets after a torrid week but underlying reasons for the turmoil remain: a weakening yuan and perceptions China's leaders are bungling their handling of the economy.

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WHAT WAS BEHIND THE STOCK MARKET SLIDE?

Government intervention after a boom and bust last year has kept stock prices at artificially high levels. Ultimately, they must come down, particularly as the government attempts to withdraw its support measures. The slowdown in the Chinese economy is also a negative; China is expected to post its weakest annual expansion in a quarter century when fourth quarter growth data is released later this month. An ill-thought-out "circuit breaker" trading halt system, which kicked in twice this week, also added to volatility. One big reason is the weakening yuan. Investors were spooked Thursday when the government guided the tightly controlled currency sharply lower, in what was interpreted as a panicked effort to stimulate the economy by helping beleaguered exporters. That weakness is a bigger incentive for Chinese investors to sell shares and move money overseas.

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WHAT DOES IT MEAN FOR THE REST OF THE WORLD?

Foreign investors have limited ownership of Chinese stocks because the country's financial system is still largely fenced off from the world. However, the country's rising economic clout mean fluctuations on the Shanghai stock exchange have the power to rattle investor sentiment and hit the portfolio values of everyone from mom and pop investors to big pension funds. Still, a bigger impact, both positive and negative, could come from the weakening the Chinese currency, since it would affect commerce and consumers around the world.

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WHAT'S HAPPENED LATELY WITH THE YUAN?

Beijing has gradually loosened the reins on the tightly controlled currency, pledging to let market forces have greater influence on the exchange rate. Economists were expecting the yuan to decline as China's economy weakens but what's come as a shock are a few sudden movements over the past half year. In a surprise move in mid-August, China's central bank set the daily target rate 1.9 percent lower, the biggest one day change in a decade. The next day it fell another 1.6 percent. Another sharp drop came on Thursday, when the yuan rate fell to its lowest in about five years.

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WHY IS THE YUAN WEAKENING IN THE FIRST PLACE?

China's currency controls link the yuan to the U.S. dollar, which has risen strongly over the past year and resulted in the yuan becoming 10-15 percent overvalued. That has compounded problems for China's exporters, who were already facing higher wages at home and a sluggish global economy. "A level of the currency that would make sense for the U.S. doesn't make sense for China," said Louis Kuijs, head of Asian economics of Oxford Economics. Analysts believe Beijing is letting the renminbi, as the yuan is also known, fall but is finding it difficult to control the speed of its descent because of speculative pressure in the offshore yuan market. "Some forces attempt to make profit from speculating on the renminbi," the People's Bank of China said in an editorial posted on its website Thursday. "This kind of trading ... only leads to abnormal fluctuations in the yuan's exchange rates."

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ARE CHINA'S LEADERS UP TO THE JOB?

In a little more than two decades, Chinese leaders have overseen a transformation that has lifted hundreds of millions out of poverty and made China into the world's second-largest economy. In hindsight, that may have been the easy part. Now that growth is slowing, the challenges multiply and Beijing's ham-fisted handling of its stock market turmoil this week is eroding the image of China's Communist Party leaders as a skilled managers. "Unfortunately, this sends signals that at least in area of the stock market, policymakers are making big mistakes and are going back and forth and have kind of lost the game on policy," said Kuijs.